What are tariffs? How Trump's tariff plan would work, who pays them, and how they could affect prices

• President-elect Donald Trump has threatened to slap tariffs on goods from Mexico, Canada, and China.
• Tariffs raise money but may also affect prices and employment, and they can lead to trade wars.
• Here's a guide to tariffs, including who pays them, how they work, and how they affect the economy.

Tariffs are back in the spotlight after President-elect Donald Trump pledged to impose 25% tariffs on goods from Mexico and Canada and an additional 10% duty on goods from China, unless those countries stop the flow of illegal immigration and narcotics into the US.

Trump's tariff threat could be a negotiating ploy to win better terms with America's three biggest trading partners. But if the tariffs are imposed, they could affect prices, employment, and the broader US economy — especially given the risk that China, Canada, and Mexico may retaliate with tariffs, triggering a trade war.

Here's what you should know about tariffs and why they matter.

What are tariffs?

A tariff is effectively a government tax specifically levied on foreign goods imported into a country.

Tariffs date back more than 200 years and were historically used by authorities to raise money. The US government collected most of its revenue from tariffs before introducing an income tax in the early 1900s.

Authorities now use tariffs primarily to protect domestic industries from foreign competition and punish trading partners for bad behavior.

There are four types of tariffs:

• An ad valorem tariff is calculated based on the value of the good. If an imported product is worth $10 and the tariff is 10%, the importer has to pay $1.
• A specific tariff is imposed on a per-unit basis, so the value of the item doesn't matter. An importer might have to pay $1 for every pound of cocoa beans it brings into the country, whether it brings in 10 bags or 1,000.
• A compound tariff combines elements of ad valorem and specific tariffs. The tariff on an imported item could be $1 per pound or 5% of its value, depending on which generates more revenue.
• A mixed tariff applies both an ad valorem and a specific tariff, meaning an importer might have to pay $5 a pound and 10% of its value as well.

Who pays tariffs? How do they work?

The news that Trump threatened Canada with tariffs, along with Mexico and China, has made it important to understand who pays tariffs and how they work.

In the US, the simple answer is that the person or business importing the tariffed product into the US pays the tariff, and the money is paid to the US Treasury.

For example, if General Motors imports parts from its factories in Mexico and assembles its cars in the US, it would have to pay tariffs to bring in those parts.

Customs and Border Protection agents collect tariffs at 328 ports of entry, including docks, airports, and border crossings.

How do tariffs affect prices and the economy?

Tariffs raise costs for importers, and to protect their profit margins, importers typically pass on those costs by charging higher prices to their domestic customers — whether they're companies or consumers.

Those price hikes can benefit domestic producers because the hikes make their goods relatively cheaper to bring to market than imported alternatives. For example, they might make it easier for US apparel manufacturers to compete with Chinese fast-fashion companies such as Shein and Temu.

Tariffs can also spur foreign producers to drop their prices to try to keep their products competitive, hurting their domestic industry and their country's economy, and partly offsetting the upward pressure on prices from tariffs.

The countries involved may also trade lower volumes of the product if both supply and demand fall in response to the tariffs.

A 2019 research paper on the initial impact of Trump's first-term tariffs found they fully passed through into the domestic prices of imported goods — and hurt consumer choice by reducing the availability of imported varieties.

Tariffs are frequently pitched as a tool to protect domestic jobs. A National Bureau of Economic Research working paper published in January found that the 2018-2019 trade war did not affect employment in newly protected sectors. The study also found that retaliatory tariffs from other countries contributed to job losses in domestic sectors such as agriculture and were only partly mitigated by federal subsidies.

Advantages of tariffs can include stronger domestic industries, increased government revenue, and pressure on other countries to stop unfair trading practices and help address issues such as illegal immigration and the drug trade.

Disadvantages can include tariffs' effects on consumers in terms of higher prices and reduced choice, plus the risk of retaliatory tariffs that could lead to employment losses in some industries and a full-blown trade war.

Moreover, a study published in The Economic Journal in 2021 found that retaliatory tariffs "disproportionately targeted more Republican areas," suggesting they were aimed at Trump's base to try to maximize their political power.

How Trump's tariff plan would work

Trump is no stranger to using tariffs. He called himself "Tariff Man" during his first term for imposing tariffs on products such as steel and aluminum plus a wide range of Chinese goods.

He replaced the North American Free Trade Agreement with the United States-Mexico-Canada Agreement in his first term, allowing most goods to continue freely passing between those countries.

That would change if Trump goes ahead with sweeping tariffs on Mexican and Canadian goods. Products passing into the US from its northern and southern borders would be subject to duties, and the money collected would flow to the US Treasury.

A key question is whether the tariffs would result in higher inflation. Inflation, or the annualized pace of price increases, hit a 40-year high of more than 9% in 2022, spurring the Federal Reserve to raise interest rates from nearly zero to above 5% in less than 18 months.

Inflation has dropped below 3% in recent months, freeing the Fed to begin cutting rates. The question is whether Trump's tariffs would cause price growth to accelerate again and delay further rate cuts — especially as people's deep concerns about higher living costs was a key reason they reelected him.